THE BALANCE SHEET Also called ‘Statement of Financial Position • Before looking at the Balance Sheet for Businesses we will recap at similar ideas for individuals • Create definitions of the following terms:- • Assets • Liabilities • Learning Outcomes • Describe the parts of the Balance Sheet. • Explain two problems highlighted in Balance Sheet.
This is Dave He owns a house worth $1.2 million. Class discussion: Is Dave a millionaire? Dave has a mortgage of $500,000 Question: How much of the house does Dave actually own?
Equity = Assets minus liabilities. Commonly defined as all that you own less all that you owe. Equity can also be called Capital or Net Assets. Equity is a similar concept to Net Worth – but applied to businesses not people Copy the Blue Notes
Julie Barker’s Assets and Liabilities as at 30 June 2015 Activity Classify the list as either Assets or Liabilities Copy the Diagram
Assets and Liabilities • What a business (or person) owns • These are called assets E.g. ? • Two types:- • Current – Will be owned for less than a year • Non Current – will be owned for more than a year. E.g. Fixed Assets • Most businesses (and people) owe money or services to other people or institutions such as banks • These are calledliabilities E.g. ? • Two Types:- • Current – Must be paid in the next year • or Non Current – Will be paid in full in more than a year. Copy the Blue Notes
The accounting equation is now stated as:- Equity = Assets - Liabilities Current Liabilities & Non Current Liabilities Current Assets & Non Current Assets Copy the Blue Notes
Working Capital Current Assets less Current Liabilities. The “cash” available for day-to-day operations. It's used to pay bills. Activity: Imagine Julie was a business - Calculate her Working Capital. Is this situation a problem? CA – CL = WC Cash Flow Problem - When a business/ person does not have enough current assets to meet their current liabilities. Working Capital is low or even negative. Activity: Solving Cash Flow Problems – Activity Sheet.
Balance Sheet: To measure assets, liabilities at a point in time
John Bite, owner of a music retail store called Dig Music, has recorded the items below for the yearending December 31, 2020. • Activity: Produce the Balance Sheet for December 2020 and calculate the Owner’s Equity. • Analysis Questions:- • Calculate John’s working capital. Is it safe? • Calculate the percentage of the business that is owned by John
High Gearing – A problem Gearing measures the proportion of a firm's assets are funded by owner's funds versus liabilities. If the proportion is high (Above 50%) – it is termed high gearing. This is considered risky. A business with high gearing is more vulnerable to a decrease in sales because the company must continue to:- • Pay Interest on its debts and • Repay its debts even though limited revenue is coming in. A greater proportion of equity provides a cushion to protect the business. Solution to this problem • Owner invests more funds to repay liabilities – this will increase equity. • Stop taking profits out of the business – This will mean assets can be funded by business cash rather than liabilities . Activity - Over two thirds of Dig records has been funded by liabilities – is this a problem?
Learning Review Activity – What have you learned? • What are the five main parts of a balance sheet? • Which two problems highlighted in Balance Sheet? • Give two solutions to each problem?